A quick primer on the averages that define our daily financial lives.
When we ask “How did the market do today?” we’re usually looking for averages like the Dow and the Standard & Poor’s 500. But we tend to be unclear about how they came about and what they really reflect.
The three best known Dow Jones averages are the Industrials (30 stocks), Transportations (20 stocks), and Utilities (15 stocks). The originator, Charles H. Dow, began working on the concept of a benchmark or market barometer in 1884, and the results of his research, an 11-stock average, were first published in The Wall Street Journal on May 26, 1896. By 1929, the original average had split into Industrials and Railroads (later renamed Transports), and a third, comprised of major utilities, was added. Over the years, Dow Jones has expanded its indices into many other areas.
Today, the Industrials remain the most closely watched Dow average. It is still made up of 30 stocks, with a mean market capitalization of $119 billion. The top five Dow component companies are IBM, Caterpillar, Chevron, 3M and United Technologies. Changes in the Dow occur infrequently, usually the result of mergers, acquisitions or reorganizations.
The Standard and Poor’s corporation provides information on dozens of averages and benchmarks for various industries, sectors and geographical areas throughout the world. Its best known U.S. benchmark, the S&P 500, is a 500-stock index of the largest publicly traded firms in the country, which represent more than 75 percent of the total market value of all U.S. stocks. The S&P 500 is actually a component of a core 1,500-stock average, which includes the MidCap 400 and the SmallCap 600. Taken together, these three represent the 1,500 largest publicly traded companies in the U.S.
In a cap-weighted index like the S&P, the representation of each company is based on its market capitalization, or the share price times the number of shares outstanding. The largest component companies of the S&P 500 include Exxon, Apple, Chevron, IBM and General Electric. Criteria for inclusion include liquidity, financial stability and reporting transparency, as well as size and share float. In contrast to the Dow, the list of companies comprising the S&P is intentionally dynamic, in order to reflect the gain and loss in market capitalization of its components.
No one average or benchmark is better in and of itself, and the numbers are only at best, a brief illumination of this complex and many dimensioned reality.
Steven Weber is a Registered Investment Advisor and Director of Investments for the Bedminster Group, which provides fee-only investment, estate and financial planning services. The information contained herein was obtained from sources considered reliable. Their accuracy cannot be guaranteed.
The opinions expressed are solely those of the author and do not necessarily reflect those from any other source.